Home New mexico real estate Schwazze Stock: An Unexpected Opportunity for Savvy Cannabis Investors (OTCQX: SHWZ)

Schwazze Stock: An Unexpected Opportunity for Savvy Cannabis Investors (OTCQX: SHWZ)

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This article assesses Schwazze (OTCQX:SHWZ), aka Medicine Man Technologies, in light of the Q1 2022 quarterly report released on May 16. Company outlook update needed in light of sharp share price decline from the report. In this article, we’ll take a detailed look at the quarterly report and see what it means for the business going forward.

The company

Schwazze is a relatively new company engaged in the growth, manufacturing, distribution and sale of cannabis. Although it first went public in 2016, it is much newer in its current form. At the end of 2019, it began to receive a series of large capital injections and a management change led by Dye Capital. In early 2020, it refocused all of its activities on Colorado. In early 2022, it added operations in New Mexico, where recreational cannabis was legalized on April 1, 2022. It currently has no plans to expand beyond those two states. For more details, see my Seeking Alpha article on Schwazze from April here.

price action

I first brought Seeking Alpha readers’ attention to Schwazze in April 2022, when the stock price was $1.88. The price is now $1.42, down 24%. The cause of the decline was a quarterly report that showed a surprisingly large loss compared to analysts’ estimates. This is a good example of the ready, shoot, aim attitude of a market that reacts to headlines first and foremost. Looking at the details of the report, it is clear that the market’s reaction was completely unwarranted and that the stock price decline is an unexpected gift for astute investors.

The quarterly report

Schwazze announced a sizable loss of $26.8 million for the first quarter of 2022, a loss of 0.38 per share against analysts’ expectations for a profit of 0.03. The startling nature of this loss can be seen in this chart of the companies’ financial statements from when they refocused activity in early 2021.

($ million) Dec 2020 March 2021 June 2021 Sep 2021 Dec 2021 March 2022
Revenue 7.9 19.3 30.7 31.8 26.5 31.8
Revenue cost 7.3 12.1 15.8 16.8 14.4 20.8
Gross profit 0.6 7.3 14.9 15.1 12.1 10.9
Operating result -8.8 -1.5 4.4 3.8 3.6 -4.8
Earn more. Operations. -8.5 -3.6 4.4 1.0 12.8 -26.8

CFO Nancy Huber’s detailed questions and answers on the loss of revenue call transcript are very informative. First, $13.4 million was due to a liability derived from their convertible debt. This is a non-cash charge based on the market value of this debt. This causes a negative P&L effect when the stock price goes up and a positive effect when the stock goes down. It has nothing to do with the underlying performance.

There was also an expense of $6.3 million for increased inventory. This was primarily in preparation for the start of recreational activities in New Mexico. Since New Mexico only opened on April 1, none of the $6.3 million was matched by sales. Undoubtedly, a good chunk of that inventory has already left stores, based on early sales reports from NM. Additionally, a portion of this inventory was related to the Colorado acquisitions that were completed during the quarter.

Other costs included non-cash items of $2.5 million for depreciation and amortization and $1 million for stock-based compensation. There were cash costs of $2.8 million for acquisitions and $7.3 million for interest.

In summary, there was a significant impact of a number of one-time cash and non-cash costs lumped together in a quarter. The $26.8 million loss included $16.9 million of non-cash accounting costs, $9.1 million of acquisition costs that will generate growing revenue streams in the future, and fees higher interest of $7.3 million which will be used to generate future income. Such is the nature of emerging growth companies in a new industry.

It was a tough quarter for many cannabis companies. Year-on-year comparisons were difficult due to stimulus-fueled 2021 sales, and the entire industry appeared to be in a lull where growth investments were just beginning to translate into revenue. Additionally, the Boulder Fire has disrupted business in one of the major cannabis-consuming areas of the Schwazze Territory. As a result, there were slight decreases in customer visits and basket size. Industry-wide wholesale pricing pressures reduced wholesale revenues by $2.2 million.

Schwazze’s underlying business is stronger than ever. Revenue increased 20% sequentially and 64% year-over-year. Adjusted EBITDA increased to $7.9 million and gross margin net of purchase accounting increased from 48.7% to 54.1%. More importantly, the company’s projected annual run rate for Q4 2022 is still $220-230 million, unchanged from Q4 2021.

A story

Hiking in the Scottish Highlands

Scottish Highlands Business and Weather Course (photo by the author)

Is the water used to create single malt Scotch a sacred ingredient? A few years ago my daughter and I embarked on the 96 mile trek known as the West Highland Way. It was a week of breathtaking beauty, albeit difficult weather, in the incomparable Scottish Highlands from Milngavie to Fort William. The first day we noticed the Glengoyne distillery just off the trail and felt compelled to investigate. Glengoyne has been making single malt whiskey since 1833 and looked like what you might expect – the old distillery building on the left, the tasting house on the right and between them the stream which provided the water for whiskey making . Across the road were several large modern industrial type buildings with the Glengoyne logo that looked very out of place. It turns out that Glengoyne was now owned by Ian MacLeod Distillers, a much bigger and big-buying entity. They had taken over the sleepy, old-fashioned Glengoyne and ramped up production and sales several times over in a new facility. They no longer even used the water from the original stream, as it was no longer sufficient for production needs. MacLeod has done this many times, growing a group of small independent distillers into a large, successful company with over 30 brands.

Schwazze engaged in a similar strategy. They enter existing markets, acquire businesses to which they can apply their expertise in production, distribution and marketing, and transform themselves into parts of the business producing to their highest potential. It’s a proven strategy that has driven the growth of many admired companies – Diageo, VF Corporation, Coca Cola and Proctor and Gamble to name a few. It’s also a contrast to much of the cannabis industry, where there’s a rush to expand as quickly as possible in as many states as possible. One sign that Schwazze is succeeding is that in Colorado they outperform the rest of the state by more than 10%.

There are risks with Schwazze, as with any high-growth company in an emerging industry. The sector has fallen in concert with other high-growth sectors this year, with most cannabis stocks falling 50% or more. It is unclear if or when strong growth will return to investors’ favor, and at what cost. Companies are left to fundamentals to support prices. In this regard, Schwazze should do well due to its profitable operating history, but only if, as expected, it returns to profitability in the coming quarters as expected.

Stock price and recommendation

Schwazze price table

Shwazze Price Chart (Yahoo finance)

Since the May 16 quarterly report, Schwazze’s stock price is down 24% from $1.77 to $1.42. In my opinion, this is a gift for investors, and I reiterate my BUY recommendation on the company. The quarterly loss was mainly due to the “fatness” of the financial results of small emerging growth companies and masks the continuous and uninterrupted development of the company. In accordance with best investment practice, positions in the business should be built up in increments, adding a third or a quarter of a full position at regular intervals. This way, investors can avoid irrational enthusiasm and take a measured approach with a stock that is currently experiencing price weakness. Based on positive past performance that is expected to pick up as soon as next quarter, Schwazze is ready to reward the savvy investor.